Initial Report: ZTO Express (NYSE:ZTO), 35% 5-yr Potential Upside (EIP, Jonlon YIONG)
Jonlon presents a "BUY" recommendation based on its competitive advantage and China’s robust e-commerce growth
LinkedIn: Jonlon Yiong
Executive Summary
Why ZTO Express?
ZTO Express was explored because it is one of the largest players in China’s logistics market and is renowned as a cost leader. Their proprietary "Zhongtian system" has significantly advanced their automation processes, giving them a strong technological edge. Additionally, China’s robust e-commerce growth and increasing demand for efficient logistics services make it an attractive market. This competitive advantage in automation and cost efficiency sets ZTO apart from other market players.
Company Overview
ZTO Express (Cayman) Inc. provides express delivery services and various value-added logistics solutions across the People's Republic of China. Leveraging a highly scalable network partner model, the company offers cost-effective express parcel delivery services. ZTO Express serves a diverse clientele, including e-commerce platforms, traditional businesses, and other express service users, ensuring extensive geographic reach at competitive rates.
Revenue Driver
4 Main Categories of Products and Services: ZTO operates through 4 main business segments 1) Express delivery services, 2) Sale of accessories, 3) Freight forwarding, and 4) Others. Express delivery services accounts for the majority (92.37%) of the firm’s revenue.
High Revenue from Express Delivery Services: ZTO Express has the number 1 market share by parcel volume in China’s express delivery industry since 2016, delivering 30.2 billion Parcels in 2023.
Revenue is primarily driven by: Parcel volume and the network transit fee that ZTO charges their network partners for each parcel going through our network.
Highly Dependent on development of e-commerce industry and emergence of New Retail in China: more than 90% of total parcel volume was attributed to e-commerce.
Figure 1: Revenue breakdown of ZTO's different services
Cost Driver
Express Delivery Services Cost includes: Line-haul transportation cost, sorting hub costs, and other costs of revenue (which include information technology-related costs, dispatching costs to network partners, etc).
Cost of Accessories Sold include: accessories that ZTO sells to their network partners
Freight Forwarding Cost relates to: Freight Forwarding services provided by China Oriental Express Co. Ltd which was previously acquired by ZTO.
Figure 2: Cost breakdown of ZTO key line items
Business Model
Figure 3: Taken from ZTO's quarterly announcement detailing overview of their business model
ZTO Operates a Network Partner Business Model: As of December 2023, ZTO has over 31,000 pickup/delivery outlets and over 6,000 direct network partners. ZTO utilises this network partners to directly interact and serve end customers.
Express Delivery Service Payment Breakdown: The full delivery fees collected by pickup outlets upfront from the senders comprise i) pickup service fees, ii) the network transit fee which is payable to ZTO and iii) the last-mile delivery fee payable to network partners who operate the delivery outlets and individual couriers.
Express Delivery Process:
i)Parcel Pickup: This is arranged through a network partner’s outlet, where a courier collects the parcel from the sender and forwards it to the regional sorting hub.
ii)Parcel Sorting and Line-Haul Transportation: Upon receiving parcels from various pickup outlets within its coverage area, the sorting hub processes, repacks, and dispatches them to the destination hubs. ZTO provides line-haul transportation between these hubs.
iii)Parcel Delivery: At ZTO’s destination sorting hub, parcels are unloaded, sorted, and subsequently delivered to recipients through delivery outlets operated by ZTO’s network partners.
Industry Overview
Figure 4: China's e-commerce gross merchandise value (Source: Statista)
China has the world’s largest e-commerce market. According to Statista, the market is expected to grow at a compound annual growth rate (CAGR) of 9.95% from 2024 to 2029, reaching a projected volume of $2,361 billion by 2029. The e-commerce penetration rate is anticipated to rise from 78.8% in 2024 to 97.4% by 2029.
Figure 5: China's parcel delivery volume in million by express delivery providers (Source: Statista)
The rapid growth of e-commerce in China has significantly reshaped and accelerated the development of the logistics and express delivery sectors. Driven by strong e-commerce demand, supportive government policies, technological advancements, and increasing cross-border shipments, China’s express delivery market is projected to grow from 125 billion parcels in 2023 to 188 billion parcels by 2027, representing a CAGR of 10.7%.
Drivers of China's Express Delivery Market
Strong demand from e-commerce: Given that e-commerce accounts for most of the demand for express delivery, the continued rapid growth of e-commerce is expected to remain the primary driver of China's express delivery market.
Favourable government policies: China is supporting the e-commerce market by establishing a modern logistics infrastructure network with a total of 120 national logistics hubs and about 100 national major cold chain logistics bases in the next few years to come.
Technological Advancement: The adoption of new technologies and automation solutions in express delivery operations has accelerated. Innovations include unmanned technologies like drones and robot delivery vehicles, along with artificial intelligence to automate processes. These advancements enhance efficiency, improve service quality, and increase delivery capacity.
Rising demand for cross-border express delivery: Under China’s 14(th) Five Year Plan, the state plans to promote cross-border e-commerce via expansion of China’s e-commerce markets to overseas markets; connecting domestic producers and suppliers to consumers overseas.
Competitive Landscape
Figure 6: Market share split between express delivery providers in China by parcel volume deliveries (Source: ZTO Express Estimate)
Market Share: The express delivery market is oligopolistic, dominated by a few key players, but with a growing number of smaller competitors. ZTO leads the market with a 19% share in parcel volume as of the latest quarter. Together, the top five companies — J&T China, STO, Yunda, YTO, and ZTO — control 70% of the market. Despite this concentration, the number of smaller competitors has been increasing in recent quarters.
Porter's 5 Forces Analysis
Figure 7: Porter's Five Forces overview
Barriers to Entry: The Chinese express delivery market has mid-to-high barriers to entry due to the high initial capital investment required to purchase and own their own fleet of delivery vehicles. Additionally, owning infrastructure such as warehouses and sorting facilities can add to costs. Investments in tracking systems and delivery management software also require capital.
Supplier Power: ZTO has moderate bargaining power over its suppliers (e.g. fuel providers, vehicle manufacturers), due to its ability to purchase in large quantities that can lower unit cost and hence purchasing prices. Furthermore, due to the firm’s size, ZTO sign long-term contracts with suppliers to secure favourable terms and pricing.
Customer Power: Customers have high bargaining power. Customers in this market tend to be very price sensitive, meaning that high prices might end up causing customers to switch brands to enjoy more competitive prices. This makes it paramount for ZTO to optimise operations to enjoy savings in line-haul transportation and sorting costs, leverage economies of scales and explore other cost savings methods to lower their Average Selling Price (ASP).
Competitive Rivalry: Highly competitive, numerous oligopolies (YTO Express, STO Express, Yunda) vying for market share. Price competition is also intense, as firms try to undercut one another with price wars. In addition to pricing strategies, firms also compete on service quality, delivery speed, and other differentiating factors to stand out in the crowded marketplace.
Threat of Substitutes: Low threat of substitutes. While traditional postal/delivery services and self-delivery exist, they do not offer the same speed and convenience as express delivery services.
Competitor Analysis
The competitors including ZTO are collectively known as the "Tongda Operators", where they represent the top five national express delivery companies that adopt the network partner model. Each player provides line-haul transportation, sorting, and waybill services to its network partners in exchange for fees, while their local network partners provide first-mile pickups and last-mile delivery services under the Tongda’s brand and collect customer payment. Notably, J&T Express is the latest entrant into the space, having been founded in 2015, acting as a logistics service provider specialising in express delivery business for major e-commerce platforms such as Alibaba and Pinduoduo. Despite being new to the market, they have captured circa 11% of the market share within three years of entering the Chinese market through an aggressive merger & acquisition strategy of acquiring smaller network and infrastructure players, including Bext Express and Fengwang Express to strengthen their business distribution network in China.
Comparision of the Network
Figure 8: Average selling price, sorting facilities and fleet capacity of Tongda Operators. (Source: Company's Annual Report and Investor Relations)
Competitive Advantage
Figure 9: Average transportation and sorting cost of ZTO
First-mover advantage in capacity and automation investment lowers unit-cost
Leveraging Artificial Intelligence (AI), ZTO has managed to improve their load rate and optimize route planning for delivery vehicles, lowering transportation costs.
Automated sorting equipment along with better economies of scale is projected to lead to additional cost-cutting of between 15-20%, which will materialize over the next 2-3 years. Sorting costs dipped 18.8% in 4Q 2023 compared to a year ago.
Being the first-mover to use such transformative technology drives down unit cost that allows ZTO to adopt more competitive pricing.
Thesis
Thesis 1: Superior asset management and margins poises ZTO as a competitive lead
Figure 10: Net Income Margin comparison between ZTO and peers
Figure 11: Return on Asset (%) comparision between ZTO and peers
Mix of distribution network partners and self-owned fleet lends to superior model with strong returns and margins
ZTO’s network partnership model allows the company to reduce the capital expenditure and maintain a smaller fleet size of roughly 10,000 vehicles, which the company has maintained without the need to expand. Moreover, ZTO has continued to grow the number of distribution points allowing it to maintain their market share by servicing hard to access Tier 2 and 3 cities.
•Model has continued to demonstrate superior margins across all three contribution margins, stemming from the ability to cut down on labour cost, optimize route mix and charge at prices which provide reasonable incentives that has allowed them to retain distribution partners
•Short-term declines in net income are industry wide from the recent pricing battles, higher freight costs and weaker economic sentiments, nevertheless ZTO has continued to remain superior
•Resultingly, management has demonstrated a strong grasp on the asset base required to support the current level of operations without overgrowing, which has supported the company in maintaining sizable return on assets relative to peers
While there has been a sell-off from the express carrier companies in China, ZTO remains fundamentally a strong player to capture the recovery.
Thesis 2: Superior pricing power supported by network-partnership model and integration of technology
Figure 12: Average selling price per parcel between ZTO and peers
Figure 13: Parcel volume delivery in billions between ZTO and peers
Despite pricing competition, ZTO’s model has allowed it to retain superior pricing power
Consensus was that express parcel players would see eroding margins due to price wars added with increasing freight rates and weaker parcel delivery from macro-conditions, where players would lack ability to control top-line.
•ZTO remains robust in delivering a recovery to the average selling price of the parcels relative to peers as of Q1 2024 despite temporary weakness in 2023.
•Relative to peers ZTO has continued to hold average selling prices relatively steadily indicating that the implementation of artificial intelligence and other tools to increase loading rates and road optimization provides edge that allows it reduce the ASP decline.
•ZTO reported an increase relative to previous quarter for the same period for parcels delivered supporting the ability to deliver in-spite of charging higher prices.
While there was a short-term pull-back in the overall market share based on parcels delivered, ZTO has specifically done this to capture the higher margins transportation including reverse logistics, higher weight and time-sensitive items which are valued in Tier 2 and Tier 3 cities they service.
Thesis 3: Overcorrection within the market leading to depressed multiples
Figure 14: ZTO's historical Price-to-Earnings ratio 2021-2024
Figure 15: ZTO's historical Earnings Per Share 2021-2024
ZTO’s is currently trading below its past 5 year historical P/E ratio
ZTO is currently trading significantly below its historical P/E ratios. Over the past five years, its P/E ratio peaked at 40.59 in November 2021 and dropped to a low of 11.12 in February 2024. The median P/E ratio during this period was 26.60. As of August 16, 2024, the P/E ratio stands at 13.76. This sharp decline suggests that the stock is trading at a depressed multiple, well below its historical norms, indicating a possible market overcorrection.
ZTO’s earnings per share (EPS) has been generally been on the rise since 2019
ZTO’s annual earnings per share (EPS) has been steadily rising since 2019, with a notable 23.14% increase in 2023 from the previous year. However, EPS for the quarter ending March 31, 2024, declined from 0.377 to 0.247. This drop may be due to a strategic shift in management focus from parcel volume to the development of personal parcels and reverse logistics services.
Figure 15: Price-to-earning ratio between ZTO and peers
Fundamental Mismatch: Despite not having the lowest P/E ratio, ZTO has the strongest fundamentals amongst its competitors
Despite not having the lowest P/E ratio among its peers, ZTO Express stands out for its strong fundamentals, particularly its high net profit margin of 22.8%. This indicates that ZTO is highly efficient in converting revenue into profit. The lower P/E ratio, despite its superior profitability, could be attributed to its higher EPS. This discrepancy suggests that the market may not have fully recognized ZTO’s earning potential, possibly due to an overreaction. As a result, there may be a valuation disparity that presents a potential opportunity for investors if the market corrects this mismatch.
Environmental, Social and Governance Consideration
Figure 16: Key summary of ZTO's environmental considerations
Notably, ZTO has taken to releasing quarterly reports outlining key progress across all three pillars of ESG. While the company remains asset-light by nature of their model, other areas of key material risk is the disposal of packaging use and difficulty to curtail the third-party network providers it works with to redcue emission footprint.
Figure 17: Key summary of ZTO's social and governance consideration
ZTO has laid out their labour rights policies and does not appear to have any controversial activities to-date and seemingly standard corporate governance policies.
Valuation
Using a discounted cash flow (DCF) method to discount the next five years unlevered free cash flow, as the company cash flow is stable, to attain the free cash flow for the firm and the present value of terminal value. Using these two values, the EV/EBITDA Exit Multiple valuation method was utilised to achieve a target price of USD27.28.
Key Risks and Catalysts
Key Risk 1: First-mover advantage in leveraging A.I. to lower transportation and sorting costs might be eroded when competitors get their hands on similar technology, competitors would be able to further lower ASP and engage in more aggressive price wars.
Mitigation 1: Continue to invest in R&D to improve on their proprietary 'Zhongtian system’ to further decrease bottom-line costs.
Key Risk 2: The multitude of smaller players might be able to erode tiny portions of ZTO’s market share that when added up become significant, which could chip away at topline revenue.
Mitigation 2: Identify and acquire or form partnerships with the growing small to mid-sized market players to consolidate market share.
Catalyst 1: Improving macro-economic indicators in China will improve investor sentiment in the Chinese equities market that could drive share price up significantly to more fairly-priced levels.
Catalyst 2: EPS for 2Q 2024 picks up from $0.247 in 1Q 2024, showing increasing profitability sends a bullish price signal to the market.
Summary
ZTO remains a compelling proposition for exposure to China's express delivery market, looking to capitalise on the long-term sustained growth of the e-commerce market. The report recommends a LONG position but caveats that the broader sentiment regarding the Chinese stock market should be considered.
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.